Monday, October 29, 2012

Last season was truly memorable for Borussia Dortmund’s many
supporters, as their beloved Schwarzgelben
retained their Bundesliga
title and also secured the first double in the club’s 103-year history by
winning the DFB Cup too. Not only did they avoid the dreaded second season
syndrome, but they actually did so in record-breaking style by setting the
highest points total (81) and the longest unbeaten run in a single season (28
matches). Germany’s leading sports magazine, Kicker,
compared this achievement with Bob Beamon’s “unbelievable” long jump record in
the 1968 Olympics.

They have admirably managed to cope with the loss of key
players each season, so when they sold influential captain Nuri Şahin to Real
Madrid in the summer of 2011, his place in midfield was effectively taken up by
Shinji Kagawa, whose return from injury meant no loss in momentum. Similarly,
when the Japanese international was sold to Manchester United this summer,
Dortmund had already signed his replacement, the highly talented Marco Reus
from Borussia Mönchengladbach.

In the club’s own words, Dortmund’s performance in Europe
was “not as impressive”, as they finished bottom of their Champions League
group behind Arsenal, Marseille and Olympiacos, betrayed by their young team’s
lack of experience at this level. However, they appear to have remedied this
weakness (so far) this season with fine victories over Real Madrid and Ajax
plus much the better of an away draw with Manchester City.

"Götze - super Mario"

All this has been done with Dortmund playing an exciting,
attractive brand of football that has been appreciated by fans everywhere. Under
charismatic manager Jürgen Klopp, this is a side that attacks with pace and
defends with great intensity, proving that teams can win with style.

They have also achieved the seemingly impossible task in
football of combining victories on the pitch with financial success, though it
is equally true that sporting success has helped lead to improved economic
results. In 2011/12 Dortmund’s revenue rose by an imposing 42% to a record €215
million (€189 million excluding player sales), while pre-tax profits surged to
a hefty €37 million. Despite higher bonus payments, the wage bill of less than
€80 million can still be described as “merely average” for the Bundesliga.

These figures provide the most tangible evidence yet that
Dortmund have made a remarkable recovery from their financial difficulties of a
few years ago when they flirted with bankruptcy. In 2002 the club was forced to
sell its famous Westfalenstadion
to a real estate trust, having squandered the funds from its flotation on the
German stock exchange.

Worse was to come as the club splashed out on expensive
signings and high wages, effectively gambling on regular qualification for in
the Champions League to fund this massive spending. When this was not achieved,
they only succeeded in building up huge debts, leaving the club in a
“life-threatening situation”.

"Hummels - Mats entertainment"

The club was saved by the “never say die” spirit of their
supporters, whose “We are Borussia” campaign resulted in Dortmund’s community
of citizens, companies and public authorities combining to help repair the
finances. This included some very understanding creditors and bank managers,
who deferred stadium rent and interest payments until 2007.

Dortmund also had to take out yet another loan to help pay
the players’ salaries, while they were forced to shore up the balance sheet in
2006 with significant capital increases, which enabled the club to obtain a
more manageable debt structure and improved interest rate terms. In particular,
the club took out a 15-year loan of €79 million with Morgan Stanley, which
facilitated the repurchase of the remaining stake in their stadium from the
property fund.

The restructuring process was completed two years later,
when €50 million of cash received after signing a new 12-year marketing
agreement with Sportfive was used to fully repay the Morgan Stanley loan many
years ahead of schedule. The club promised that this move would not only
further reduce its liabilities, but would free up funds to improve its sporting
competitiveness. Two Bundesliga
titles later and it’s fair to say that the club has been true to its word.

"Lewandowski - Pole dance"

Dortmund have learned from their past mistakes (and
excesses) and adopted a far more sustainable business model in the past few
years. They now employ a solid financial strategy, based around the over-riding
principle of “achieving maximum sporting success without taking on more debts.”
The focus is primarily on youth, as explained by managing director Thomas Treß,
“We learned that you have to invest in your youth, to develop your own stars,
adding to your team with young players of potential.”

This investment in relatively cheap, promising young
players, rather than he expensive finished article, has been assisted by the
foundation in 2011 of the BVB Academy, a modern training centre to develop
players between the ages of 19 and 23. Dortmund’s youth academy has been a
veritable production line for the first team, turning out talent like Mario
Götze, Marcel Schmelzer and Kevin Großkreutz, while other youngsters like Mats Hummels and Sven Bender have been further developed at Dortmund. Most
of these players have signed long-term contracts with Dortmund until 2016 or
2017.

Bayern Munich’s outspoken president Uli Hoeneß took a pot
shot at his rivals’ approach, “They had to do it that way, because they don’t
have the money.” Well, exactly. Very few clubs have the financial power of
Bayern, but it is surely better to make your suit from the cloth available,
rather than spend money you don’t have on a fancy new outfit that falls apart a
couple of years later.

Dortmund’s revised, more sensible approach has been epitomised by
their dealings in the transfer market. In the five years leading up to the
fateful 2004/05 season, the club’s net spend was a chunky €97 million, before
their debt problems forced them to offload players, generating surpluses over
the next three years, followed by very modest spend, so that “transfer income
and expenses are balanced.” Over the last nine years, the club had net sales proceeds
of €5 million – a stark contrast to their extravagant era.

Under sporting director Michael Zorc, Dortmund’s scouting
has been focused on “value development”, so that “transfers should create
substantial earnings potential”, as well as “sustainable sporting
competitiveness”. This means that the young talent is likely to leave “to
secure large transfer income”, though the club acknowledges that this strategy
creates a conflict between financial considerations and sporting criteria. This
can lead to a lack of squad depth, hence the uncertain start to this season in
the Bundesliga.

In fact, over the last three seasons no fewer than nine
clubs in Germany’s top flight have spent more than Dortmund’s net €2 million.
In fairness, very few Bundesliga
clubs spend big on transfers with the obvious exception being Bayern Munich,
who spent €116 million in the same period. Dortmund’s chairman, Hans-Joachim
Watzke, accepted this discrepancy, “I must point out that we continue to
operate in different spheres. Bayern spent €70 million this year, including €40
million on Javi Martinez.”

Thomas Treß added, “We are not able to compete in the
European soccer market with British or Spanish clubs in respect of transfer pricing.”
That’s true, but you can also add a few more countries to that list, as can be
seen by the above graph, which highlights the massive difference with other
leading Europe clubs. At one end of the spectrum, we have Dortmund with €2
million; at the other end, three clubs, fueled by oil-rich owners, have
splashed out around a quarter of a billion pounds: Chelsea, Manchester City and
Paris Saint-Germain.

This summer saw a slight change of emphasis with the €17
million capture of Marco Reus, though even this was compensated by the €16
million received for Kagawa. Bayern’s former sporting director, Christian
Nerlinger, conceded, “With this transfer they have established themselves as a
major rival for the championship.” Dortmund claimed that this signing demonstrated
that they were “the team to be for young, ambitious Bundesliga players”, though in fairness
there were special circumstances here, as Reus grew up as a Dortmund fan and
his parents live in the area.

Nevertheless, the suspicion remains that if they receive the
right offer, Dortmund will continue to sell their best players, such as the
prolific forward Robert Lewandowski. Watzke recently denied this, “We won’t
give up Robert for any money in the world. We don’t want to open a bank”, but
few would be surprised if the Polish international were to leave next summer.

Indeed, player sales contributed nearly half (€17 million)
of Dortmund’s very impressive 2011/12 pre-tax profits of €37 million, which
were €27 million higher than the previous season’s profits of €10 million.
After tax was taken into consideration, profits increased from €5 million to
€28 million. That was much more than the previous five years when player sales
produced profits on average of less than €5 million a year.

Operating profit grew by €17 million to €24 million, as
revenue grew by an amazing €51 million (37%) from €139 million to €189 million,
more than off-setting increases in the wage bill (£18 million) and other
expenses (€17 million). Other operating income, largely due to payments from
national associations for the release of Dortmund’s players, also improved by
€3 million to €8 million.

As a technical aside, I am using the Deloitte definition of
revenue here in order to facilitate comparisons with other European clubs, so
have excluded transfer income of €26 million. Adding that to my revenue of €189
million gives the €215 million announced by Dortmund. The profit on player
sales of €17 million is then obtained by deducting transfer expenses of €9
million and is largely due to the sales of Kagawa to Manchester United and
Lucas Barrios to the Chinese club Guangzhou.

It is clear that “Borussia has developed itself economically
and on a sporting level continuously over the last few years”, as Watzke put
it. The profits made in the last two seasons represent a spectacular
turnaround, as the club had previously reported losses in five of the last six
years, including €55 million in the annus
horribilis of 2004/05 and €23 million the year after.

In comparison, Bayern Munich, the “alpha male” of the Bundesliga with 22
league titles and four Champions League victories, have made profits 19 years
in a row, consistently bettering Dortmund’s results off the pitch – except last
season, when the Schwarzgelben’s
€9.5 million was slightly higher than the Bavarians’ €8.8 million. Bayern will
also have to go some to match Dortmund’s €37 million in 2011/12.

Dortmund re-entered Deloitte’s Money League in 2010/11 in
16th position with revenue of €139 million, even without the benefit of Champions
League money. Their 2011/12 revenue of €189 million would have placed them
11th, assuming no growth at other clubs.

That is more than respectable, but the problem is that it is
far below the leading clubs, such as Real Madrid €479 million, Barcelona €451
million, Manchester United €367 million and (crucially) Bayern Munich €321
million. The magnitude of Dortmund’s accomplishment in overcoming Real Madrid
last week can be seen by the relative revenue figures last season with Madrid’s
€514 million being nearly three times as much as Dortmund’s record €189
million.

Bayern’s revenue of €321 million is by far the highest in
Germany, giving them a major competitive advantage over their rivals: Schalke
04 €202 million, Dortmund €189 million, Hamburg €129 million, Werder Bremen
€100 million and Stuttgart €96 million (all 2011 figures, except Dortmund
2012). Moreover, only Dortmund have kept pace with Bayern’s insatiable revenue
growth: since 2007, they have both increased revenue by just under €100
million. Schalke also grew revenue by €88 million, but their 2012 figure is
very likely to fall back after the absence of Champions League revenue, which
was worth €40 million in TV distributions alone in 2011.

Even though Dortmund’s revenue has been going great guns,
rising 80% (€84 million), while Bayern’s actually dipped €2 million last
season, the gap between the two clubs is still a mighty €132 million. This is
nonetheless a lot better than the colossal €218 million shortfall in 2010, when
Bayern’s revenue was literally three times as much as Dortmund’s.

Even so, Dortmund’s revenue growth has been hugely
impressive, more than doubling from €90 million five years ago, especially as
it was relatively flat during the three years between 2008 and 2010 at around
the €105 million level. Last season all revenue streams contributed to the €51
million rise to €189 million: TV €28 million (mainly Champions League
participation) to €60 million; commercial €19 million to €97 million; and match
day €4 million to €31 million.

As we can see, the largest revenue category is commercial
income. In fact, in 2010/11 Dortmund had the highest percentage of their total
revenue from commercial (57%) of any Money League club. Although this has
fallen to 51% in 2011/12, mainly due to Champions League money, this is still a
very high proportion for a football club.

To place that into context, it is worth comparing the
revenue mix with Arsenal, where commercial activities contribute only 23% of
total revenue. In contrast, match day is worth 41% at the North London club,
compared to only 17% at Dortmund. Looked at another way, the majority of
Dortmund’s revenue is generated from companies, while fans bear most of the
burden at Arsenal.

In fact, Dortmund’s striking commercial revenue of €97 million
means that they are only behind the four marketing behemoths of the football
world: Real Madrid €187 million, Bayern Munich €178 million, Barcelona €167
million and Manchester United €130 million.

The club’s commercial strategy is to secure long-term
partners, as seen by their agreement with marketing partner Sportfive, who have
signed with the club until 2020, by which time they will have been the club’s
marketing partner for 20 years. All three main sponsorship deals are long-term
in nature: shirt sponsor Evonik, whose agreement has been in place since 2006,
extended from 2013 to 2016; stadium naming rights partner Signal Iduna also
extended from 2016 to 2021; while new kit supplier Puma signed up until 2020.

Another objective is to sign up many secondary sponsors,
known as “champion partners”, and a lengthy list now includes the likes of
Opel, Sparda Bank, Sprehe, Wilo, Brinkhoff’s, Flyer Alarm, Hankook, Yanmar and
West Lotto.

Dortmund have managed to grow all aspects of their
commercial revenue: sponsorship and advertising rose 16% to €58 million, mainly
due to new partners and an increase in the VIP hospitality occupancy rate to
100%; while merchandising and catering was also up an impressive 41% to €37
million.

Over a third of merchandising revenue is now earned through
the online shop, while a fifth fan shop was opened in the city of Dortmund in
September 2011. According to a survey by PR Marketing, die Borussen sold between 250,000 and
500,000 replica shirts in the 2011/12 season with only eight clubs selling
more. Catering revenue also rose 9% to €10 million.

Despite these successes, Dortmund’s commercial income is
still only around 55% of Bayern’s, partly due to the €38 million revenue the
Bavarians earn from the Allianz Arena, though their sponsorship and advertising
is also €23 million higher. Our old friend Uli Hoeneß said that Dortmund would
need to have a more consistent track record of winning trophies if they hoped
to match Bayern’s global appeal, but in truth they’re doing very well compared
to almost every other club on the planet.

Evonik, a chemical company, has increased its shirt
sponsorship to €10 million, according to the Frankfurter
Allgemeine Zeitung, though this is still lower than deals struck by
some other German clubs: Bayern (Deutsche Telekom), Schalke (Gazprom) and
Wolsburg (Volkswagen). It is also a long way behind the mega deals at the likes
of Real Madrid and Barcelona, though it does include hefty add-ons for sporting
success. The Evonik chairman said that he was very pleased with Dortmund as a
partner, due to their large crowds and title wins (“in a very exciting way”).

German clubs have proved very adept at securing valuable
shirt sponsorship deals. Although the total value of such deals is higher in
the Premier League, the average value of each deal is actually higher in the Bundesliga, as it
has two fewer clubs (according to a study by International Marketing Reports).

Signal Iduna, the naming rights partner, has also increased
its annual payment from €4 million to between €4.5 and €5 million after the
deal extension.

Dortmund’s new kit supplier, Puma, is reportedly paying €6-7
million a season from July 2012, replacing Kappa, whose deal was only worth €4
million. Rather wonderfully, the new shirt has the inscription “Echte Liebe” (true
love) on the inside of the collar. That’s good news, but it is still far below
Bayern’s €25 million deal with Adidas (and, for that matter, Real Madrid’s €38
million agreement with the same company).

Paradoxically, BVB arehelped commercially by the weak digital television market, which means
that German clubs are televised more frequently on terrestrial channels than
their counterparts in England, Spain and Italy, thus providing more exposure
for their sponsors. As the old saying goes, it’s an ill wind that blows no
good.

However, this also means that television income is not very
high in Germany, as can be seen from the 2010/11 Money League, where Dortmund
sat in 19th position. Their revenue of €32 million was around one sixth of the
€184 million earned by Barcelona and Real Madrid, who benefit greatly from
their individual domestic deals.

In 2011/12, Dortmund’s TV revenue rose €28 million to €60
million, very largely due to the €25 million from the Champions League with the
remainder coming from the DFB Cup, which they won compared to a second round
exit the previous season.

They received around €28 million from the Bundesliga
distribution, a small increase on the previous season. TV revenue in Germany is
largely divided among clubs via a points system based on their league position
over the past four years, though some money is also allocated per the number of
games televised live.

Performance is weighted in favour of the more recent years,
so last season a factor of 4 was applied to 2011/12, 3 to 2010/11, 2 to 2009/10
and 1 to 2008/09. However, a form of equality is then applied, as the club with
most points from this algorithm only receives twice as much money as the club
that has the lowest number of points. In this way, as top club in 2011/12
Bayern Munich received €24 million for performance (excluding live fees), which
was double the €12 million for last placed Augsburg.

The Bundesliga
recently announced an increase in the value of their TV rights with the
domestic deal for the four years from 2013/14 to 2016/17 rising 52% from €410
million to €628 million and the overseas rights increased by a similar rate to
€72 million. The new total of €700 million will take it ahead of La Liga (€655
million) and Ligue 1
(which actually fell to €642 million). The Bundesliga’s
chief executive, Christian Seifert, was ecstatic, “ We didn’t expect results
like this, it clearly exceeded our expectations”, while Bayern’s chief
executive, Karl-Heinz Rummenigge, described it as “a milestone in the history
of the Bundesliga.”

Nevertheless, the TV rights for German football are still
lower than Serie A
(€944 million) and only half the Premier League deal (€1.4 billion). That is
before the new English deal from 2013/14, which is estimated to be worth at
least €2.2 billion, i.e. three times the “historic” Bundesliga deal.

Dortmund’s share of the TV revenue should rise to around €40
million, but this is still a lot less than the money earned by English clubs.
Last season’s Premier League winners, Manchester City, pocketed €75 million,
while even the bottom club, Wolverhampton Wanderers, received €49 million. The
new Premier League deal is likely to deliver €110-120 million to the leading
English teams.

Once again demonstrating their innovative spirit, Dortmund
were the first German club to offer their own TV package, BVBtotal!, in January
2011, run jointly with Deutsche Telekom.

Dortmund’s allocation from the Champions League was worth
€25.4 million in 2011/12, considerably more than the €4.5 million they received
from the Europa League the previous season, even though they went out at the
group stage. However, this was still a lot less than the €42 million Bayern
received for reaching the final.

Interestingly, Dortmund (€17 million) still received more
than Bayern (€14.8 million) from the TV (market) pool, due to the methodology
used to allocate this element, which is as follows: (a) half depends on the
progress in the current season’s Champions League, based on the number of games
played; (b) half depends on the position that the club finished in the previous
season’s domestic league. As three German clubs reached the group stage this
season, the split will be: Dortmund 45%, Bayern 35% and Schalke 20%. The Champions League will be worth even more, as the overall prize money for the 2012 to 2015 three-year cycle has increased by 22%, but it will be higher for German clubs, as their TV deals have risen considerably, thus boosting their market pool.

"Grosskreutz - we need to talk about Kevin"

The Europa League is much less lucrative, though German
clubs benefit from relatively high TV deals, so last season Schalke earned the
same (€10.5 million) as the winners Atlético Madrid, even though they were
eliminated in the quarter-finals.

Therefore, Dortmund will be gratified that Germany’s number
of places in the Champions League has increased from 3 to 4 (at the expense of
Italy), due to the improving UEFA coefficients. However, this might prove to be
a double-edged sword, as it could mean that Germany’s TV pool has to be shared
between more clubs.

European money has clearly made a substantial difference to
Dortmund’s revenue, but Watzke has claimed that the club is not economically
dependent on Champions League money and they could survive three seasons without
it, thanks to their long-term sponsorship contracts – though they would have to
make cuts.

Last season Dortmund’s incredible average attendance of
80,500 was the highest in Europe, ahead of Barcelona 79,600 and Manchester
United 75,400. This was easily the largest average in Germany with the next
highest teams being Bayern 69,000 and Schalke 61,200. The Dortmund fans’
interest shows no sign of slowing down, as they have just established a new Bundesliga record
for season tickets for 2012/13 at a mighty 54,000 – and that was capped to
ensure an adequate supply of tickets on the day of the match.

It is therefore a little perplexing to see that Dortmund
have one of lowest match day revenues in the Money League with only €28 million
in 2010/11 (€31 million in 2011/12), while the likes of Real Madrid, Barcelona,
Manchester United and Arsenal all collect more than €100 million. There are two
obvious reasons for this huge discrepancy: less matches and low ticket prices.

There are two fewer home games every season in the
Bundesliga, while last season Dortmund only played three Champions League home
games, bringing in €4.4 million, and one in the DFB Cup. This resulted in a
total of 21 home games compared to 28-29 for the leading English and Spanish
clubs.

Dortmund’s high attendances (and small match day revenue)
can be partially attributed to the large number of standing places for which
season tickets are priced as low as €187 (€109 for youths). Nearly 25,000 of
these can be found on the famous Südtribüne
terrace, known as the “Yellow Wall”, which is the largest standing area in
European football and provides each home game with an intensely passionate
atmosphere. Occasionally, that enthusiasm can go too far, such as the
hooliganism seen at the recent Schalke derby when there were 200 arrests and
water cannon had to be used.

It is surely no coincidence that the Bundesliga has the lowest ticket prices
of Europe’s five major leagues and consequently the highest attendances. This
is an important part of football culture in Germany, as seen recently when
Dortmund fans staged a protest against Hamburg’s steep prices for away standing
tickets, leaving their block after 10 minutes. Klopp gave them his support,
“The league needs to think just how far they want to push prices.”

There are no such problems in Dortmund’s imposing stadium,
now officially named Signal Iduna Park, which is the largest football ground in
Germany and the sixth largest in Europe. This is obviously an extremely
valuable asset that can also be used to host international matches, when the
capacity is reduced to 67,000 by converting the standing areas to seats. The
Times described it as the “most beautiful stadium in the world”, writing,
“Every Champions League final should be held in Dortmund. The place was built
for football and its fans.”

Even though the wage bill has risen by 67% (€32 million)
since 2010 to stand at €80 million, this is still very much under control, as
revenue has grown at an even faster rate of 80% (€84 million). In fact, the
important wages to turnover ratio has actually fallen to a very creditable 42%
from the peak of 48% in 2009, which is even better than the 50% targeted by the
Bundesliga.

The €18 million increase in the total wage bill in 2011/12
was largely due to sporting success, namely higher performance-related bonus
payments, though there was also a rise in administration staff. Treß emphasised
that the club had a “very flexible cost structure”, so any lessening in
performance on the pitch should mean a smaller wage bill. The wage bill is not
analysed in the accounts, but the cost of the football squad has been estimated
at €60 million.

Even after this growth, Dortmund’s total wage bill of €80
million is still only about half of Bayern’s €158 million, though the gap has
come down a fair but from 2010 when it was as high as €118 million. In fairness
to the Bavarians, their revenue is also substantially higher, but that does not
make it any easier for BVB to compete.

This point is even more relevant on the European stage,
where some of the leading clubs can boast wage bills far higher than any in
Germany, e.g. Barcelona, Real Madrid, Manchester City and Chelsea are all above
€200 million (though the Spanish figures are inflated by other sports). To
provide an English comparison, Dortmund’s wage bill is about the same as
Sunderland, Everton and Fulham, which shows just how extraordinary their
achievements have been.

That said, the price of success is that Dortmund’s wage
structure will come under pressure, as their policy of signing stars to
long-term contracts will mean higher salaries, as seen with Götze’s improved
deal.

Dortmund’s executives have also been handsomely rewarded for
the club’s success with Watzke earning €2.2 million in 2011/12, including a
€1.4 million bonus, and Treß trousering €1.4 million, including an €875,000
bonus.

The other staff cost, player amortisation, is incredibly low
at €8 million, which is a perfect demonstration of Dortmund’s conservative
transfer policy. As a comparison, player amortisation at big spending
Manchester City and Real Madrid is around €100 million, while Bayern book €33
million.

To explain this concept, football clubs do not expense
transfer fees completely in the year of purchase, but treat players as assets.
So the cost of buying players (in accounting terms) is spread over a number of
years by writing-off the transfer fee evenly over the length of the players’
contract via amortisation. As an example, Marco Reus was bought for €17 million
on a five-year deal, meaning the annual amortisation is €3.4 million.

In contrast, other expenses of €74 million seem fairly high,
though this does include €25 million for match operations, €17 million
advertising, €12 million materials (primarily merchandising) and €11 million
administration. Note: I have excluded transfer expenses from my definition.

There is further strong evidence of Dortmund’s financial
recovery with the decrease in net debt (financial liabilities) from €150
million in 2006 to €42 million in 2012, including an €18 million reduction last
season alone. This is made up of €47 million gross debt, largely a state-backed
loan for stadium expansion of €32 million (repayable in 2026) and a €12 million
fixed-interest loan (repayable in 2013), less €5 million cash. The average
weighted interest rate of the long-term liabilities is 5.5%. The club also has
access to an additional €15 million overdraft facility.

In fact, the balance sheet is quite strong with net assets
of €155 million, including €183 million of property assets, namely the stadium,
former offices at “Am
Luftbad” and the training ground at Dortmund-Brackel. In addition,
the club possesses what it describes as “hidden reserves” among the playing
staff, following its policy of recruiting young talent with a lot of potential.
Their value in the books is only €26 million, while their real worth in the
transfer market is considerably higher – €211 million according to the Transfermarkt
website.

Dortmund have generated positive net cash flow for the last
two years: €7.8 million in 2011 and €6.4 million in 2012. As a sign of the
board’s confidence, the club has proposed a dividend for the first time since
it went public in 2000 with a total payment of €3.7 million scheduled to be
discussed at the Annual General Meeting in November.

"Weidenfeller - the Roman empire"

The Bundesliga
itself is in fine shape, as Klopp explained, “We have the most competitive and
the most attractive league in Europe with the best stadiums. The fans are
great.” This is reflected in the situation off the pitch: only the Premier
League (€2.5 billion) has higher revenue than the Bundesliga (€1.7 billion), while the
German league is more profitable at an operating level (€171 million) than its
English counterparts (€75 million) with all other major leagues reporting
losses.

As part of the German rules, clubs have to provide a
balanced budget before each season in order to receive a license, which forces
them to act in a sustainable manner, as seen by an average wages to turnover
ratio of 50% (compared to 70% in the Premier League).

In addition, the “50+1” rule, which dictates that members
must own a minimum of 50% of the shares plus a deciding vote, theoretically
prevents the club being subject to the whims of an individual owner and taking
on excessive debt. This has very largely worked, e.g. debt levels in the Bundesliga are less
than a third of those in the Premier League, but the system is not completely
foolproof, as seen by the problems experienced by Dortmund and Schalke among
others.

A club as well run as Dortmund should be one of the main
beneficiaries of UEFA’s Financial Fair Play (FFP) regulations, which encourage
clubs to live within their means. As Watzke explained, “If FFP is implemented
and rigorously enforced, we have a chance to be one of the strongest teams in
Europe.”

Even the losses made between 2008 and 2010 were within
UEFA’s limits: the allowable losses are an aggregate €45 million for the first
two years (then three years), but this is only €5 million if losses are not
covered by the owners, which might be more relevant here. In any case, they can
exclude certain expenses, including depreciation on tangible fixed assets and
expenditure on youth development and community activities, which I estimate would
be worth around €13-15 million.

Watzke himself has gone further, imploring the regulators to
act tough, “UEFA must find the thin line between sponsorship and excessive
back-door funding – they must show strength to expel big clubs. No tycoon
should be allowed to pump crazy money into a club with sponsorship from five
companies he controls. If that happens, financial fair play will fail.” Of
course, some might find such a talk a little rich, given Dortmund’s own
checkered history, especially as they were given a €2 million loan at the
height of their problems by Bayern Munich (of all people).

"Bender - Sven you're young"

As to the future, Dortmund are cautiously optimistic. Watzke
sees “additional growth potential” with net profit for 2012/13 likely to be “in
the single digit million range”, assuming exits at the group stage of the
Champions League and the second round of the DFB Cup.

The chairman said that Dortmund were at the fifth stage of a
five-point plan: “The first was the struggle for survival, the second
restructuring, the third was development of a sporting philosophy, the fourth
implementation and the fifth is sustainability.” This is not just a reference
to the club’s financial status, but also the ability to maintain their
performance levels on the pitch. It will indeed be a tough challenge to
establish themselves in Europe, while also figuring prominently in the race for
the Bundesliga
title.

The club has attempted to ensure management stability by
extending the contracts of the “holy trinity” of Watzke, Zorc and Klopp to 2016,
but there are no guarantees in football. If Klopp were to leave, that might be
a hammer blow to Dortmund’s ambitions. No manager is irreplaceable, but whoever
followed the magnetic Klopp would certainly have a tough act to follow.

"Rolls Reus"

In the meantime, we should simply enjoy the fabulous
spectacle at Dortmund, where they have proved that a football club does not
have to throw money at the problem, but can win in the right way. First-class
management, astute scouting and a belief in youth development have delivered
trophies to some of the best fans around, while the team’s dazzling displays
have gained admirers throughout Europe.

That’s some accomplishment, especially as they have combined
their sporting excellence with a remarkable recovery from near collapse to a
solid financial position. Coldplay may not be everyone’s cup of tea, but the
lyrics from their breakthrough single seem strangely apposite; “Look at the
stars/Look how they shine for you/And everything you do/Yeah, they were all
yellow.”

Friday, October 19, 2012

A couple of weeks ago Barcelona and Real Madrid produced an
enthralling 2-2 draw in El
Clásico with two goals apiece from their superstars Lionel Messi and
Cristiano Ronaldo. It seemed appropriate that the latest match in a series of
titanic struggles finished level, as there has been little to separate the two
Spanish giants recently.

Their dominance in La
Liga has become unquestioned, as they have shared the last eight
league titles between them, Barcelona winning five times, while Madrid have
been victorious on three occasions, including last season. In Europe, Barcelona
have led the way, winning the Champions League twice in the last four years.
Although Madrid have not been quite so prominent recently, they have reached
the semi-finals of the last two tournaments, and they have won the trophy more
than any other club (nine times).

"Xavi - little triggers"

Despite an uncharacteristically nervous start to the season
by these two powerhouses, few would bet against La
Liga once again turning into a two-horse race. Indeed, when
questioned about Malaga’s potential, their exciting young star Isco’s downbeat
response spoke for many, “Atlético Madrid and ourselves have begun well, but
there are two teams superior to the rest and there are no others that can fight
them for the title.”

They also appear to be doing fantastically well off the
pitch, both reporting revenues of around half a billion Euros for the 2011/12
season. More importantly, both clubs registered hefty profits: Barcelona’s €49
million was their all-time record, while Madrid’s €32 million was also a
notable achievement. Equally significantly, they have also been reducing their
sizeable debts to a more manageable level.

In fact, Madrid claim that their turnover of €514 million is
the highest of any sporting club in the world after 7% (€34 million) growth
from the previous year’s €480 million. However, expenses shot up €48 million
with wages rising 8% (€18 million) from €216 million to €234 million and other
expenses surging 26% (€30 million) to €146 million, partly due to a tax law
change and higher provisions.

This meant that Madrid’s cash profits, defined as EBITDA
(Earnings Before Interest, Taxation, Depreciation and Amortisation) declined
from €148 million to €134 million. This is still hugely impressive, being €20
million more than Manchester United and €90 million more than Arsenal, two of
England’s most financially astute clubs.

After a €5 million increase in player amortisation and
depreciation, operating profit fell €19 million to €24 million, though this was
boosted by €20 million profit on player sales (and other asset disposals),
which was €17 million higher than the previous season. Net interest payable
rose €12 million, almost entirely due to a once-off financial gain the prior
year not being repeated in 2011/12.

"Casillas - number one"

This produced a profit before tax for Madrid of €32 million,
which was €15 million lower than the €47 million achieved in 2010/11. This was
still more than respectable, as club president Florentino Pérez affirmed,
“These results are spectacular, especially given the economic circumstances we
are living in.”

Barcelona’s revenue also rose 7% from €452 million to €485
million (excluding €10 million revenue from player sales), though they also
managed to cut the wage bill by 3% from €276 million to €268 million. This
helped increase their EBITDA by a stunning 39% from €89 million to €123
million, just €11 million behind Madrid. In fact, their lower player
amortisation, arising from their policy of developing players from the La Masia academy,
means that Barcelona’s operating profit of €51 million was more than twice as
much as Madrid.

However, Barcelona only made a negligible €3 million profit
on player sales, as the €11 million gain made from selling the likes of Jeffrén
and Maxwell was almost wiped out by the €8 million loss from removing Alex
Hleb, Gabriele Milito and Henrique from the books. That still represented an
improvement from the previous season, when the club made an overall loss of €22
million on player sales, as the profitable sale of Yaya Touré to Manchester
City was not enough to compensate for the large losses made on selling Zlatan
Ibrahimovic to Milan, Dmytro Chygrynskiy to Shakhtar Donetsk, Martin Cáceres to
Sevilla and Thierry Henry to New York Red Bulls.

"You've got to fight for your right to party"

Following the debt reduction, Barcelona’s net interest
payable dropped €8 million to just €5 million, leading to the record €49
million profit before tax. That’s pretty impressive for a season in which
Barcelona did not win the Spanish league title or the Champions League,
particularly when they did not sell any players for large amounts of money. No
wonder their president Sandro Rosell described this season as “excellent in
terms of numbers”, though the fans might have preferred more silverware.

In fact, without the huge losses on clearing out some of the
former regime’s expensive mistakes (the loss on Ibrahimovic alone was reported
to be an incredible €37 million), Barcelona said they would also have made a
pre-tax profit in 2010/11 of €34 million.

Actually, the picture for the football club is even better,
as these figures include large losses reported for Barcelona’s other sporting
activities. These amounted to €40 million in 2011/12 (basketball €22.9 million,
handball €7.7 million, 5-a-side football €5.9 million, hockey €2.4 million and
other sports €1.4 million), so the pre-tax profit for the football club alone
would be a mighty €89 million.

It’s a similar story for Real Madrid, though unfortunately
their annual report no longer analyses the profit and loss account by activity.
The last report to do so (in 2008/09) listed the basketball loss as €23
million. If this were the same level today, Madrid’s profit before tax for the
football club would be €55 million.

In spite of their massive expenditure, Madrid have been
consistently profitable, amassing €230 million of pre-tax profits over the last
six years, including €44 million in 2007, €51 million in 2008, €25 million in
2009 and €31 million in 2010. According to their annual report, the last time they
reported negative EBITDA was way back in 2001/02. The club is again budgeting
for a €32 million profit in 2012/13.

Barcelona’s figures have been less impressive, though they
have reported profits in four out of the last six years, albeit generally much lower.
The annus horribilis
of 2010 with its €83 million loss was largely due to the new board taking what
Javier Faus, the vice-president of economic affairs, described as a more
conservative approach and booking €89 million of audit adjustments, including
provisions for TV rights disputes, player transfers and land sales/valuations.

At that point, Faus admitted that Barcelona could not “allow
itself to continue losing money”, leading to a more austere approach, since
when substantial progress has been made on the club’s finances, resulting in
this year’s mega-profits and a budgeted pre-tax profit for 2012/13 of €36
million. Nevertheless, there is no room for complacency, as Faus acknowledged,
“We’re taking this with caution. We’re not euphoric. We want to wait two to
three years to see if we can stabilise the trend.”

In stark contrast to the big two, very few other Spanish
clubs are doing well financially. According to a study by the University of
Barcelona for the 2010/11 season, only eight of the 20 clubs in La Liga were
profitable – and Real Madrid were the only one of these to report a profit
higher than €5 million. While the two Spanish giants gorge themselves, the
other teams are starving. As Professor Gay said, “Everyone is concentrated on
Madrid and Barca, who are the kings of the banquet, while the rest live an
uncertain future.”

The picture is not too different on the broader European
stage, as the only leading club making similar profits are Arsenal, who
reported €44 million of pre-tax profits in 2011/12, though it should be noted
that they would have made a €38 million loss without the benefit of €82 million
of player (and property) sales, ironically including Cesc Fàbregas to
Barcelona.

Bayern Munich also reported a solid profit of €9 million,
the nineteenth year in succession that they have been in the black, but
Manchester United slipped to a €6 million loss (before tax), dragged down by
€60 million of interest charges, though in fairness they did make a €36 million
profit the previous year.

At the other extreme, those clubs operating with a
benefactor/sugar daddy model reported enormous losses. Manchester City’s €237
million loss in 2010/11 was the largest ever recorded in England, while
Juventus, Inter, Chelsea and Milan all registered losses at around the €80
million mark.

The source of Madrid and Barcelona’s financial supremacy is
their astonishing ability to generate revenue. Domestically, they are so far
ahead of the other clubs that it is questionable whether they are even
competing in the same race. In the 2010/11 season, their respective revenue of
€479 million and €451 million (very slightly adjusted to be in line with the
Deloitte Money League) was around four times as much as the nearest
challengers: Valencia €117 million, Atlético Madrid €100 million and Sevilla
€83 million. The rest were absolutely nowhere with two of the clubs in Spain’s
top division reporting annual revenue less than €10 million.

That’s bad enough, but the problem is that it’s getting
worse, as only the big two have managed meaningful revenue growth over the last
few years, while the others have been stagnating. In the three years between
2008 and 2011, Barcelona and Madrid increased their revenue by €142 million and
€113 million respectively, while the closest to that was €21 million by
Atlético Madrid and €16 million by Valencia. Athletic Bilbao’s revenue has been
flat, and it has actually declined at Sevilla and Villarreal.

In 2012 it’s more of the same with the two giants both
adding a further €34 million to their revenue. In short, the gap between the
elite and the “working class” is already immense – and it’s getting wider every
year. As Sevilla’s outspoken president José Maria del Nido said, “Revenues are
making the big get bigger and others smaller.” The chances of Sevilla (or
indeed anyone else) mounting a sustained challenge in Spain are virtually zero,
unless one of the big two somehow implodes.

In fairness to the Spanish clubs, the theme is essentially
the same in Europe with Madrid and Barcelona earning around €100 million more
than the third placed club, Manchester United, and €150 million more than
Bayern Munich. Their revenue is an incredible €200 million more than Arsenal,
Chelsea and Milan. Moreover, they earn the highest television money and only
one club betters them on commercial revenue (Bayern Munich) and one splits them
on match day income (Manchester United).

Furthermore, the distance to the chasing pack is also
growing year after year. Since 2005, the first year that Madrid topped the
Money League, their revenue growth has been considerably higher than the other
leading clubs. In that period, Madrid’s revenue rose by €204 million, while
Barcelona’s growth of €243 million was even more impressive. The next highest
increases were barely half that: Bayern Munich €131 million and Manchester
United €121 million.

The distance to their peers has been steadily increasing
from €39 million in 2009 to a staggering €130 million in 2012. In other words,
everyone else has massively lost ground in relative terms. Given this
significant competitive advantage, Real Madrid and Barcelona should at the very
least reach the Champions League semi-finals every season (and this is indeed
one of their budget assumptions).

It’s more of the same in 2012, as the Spanish leaders
continued their growth story, while the only other clubs to publish their
results for last season either only grew slightly (Arsenal) or even fell back
(Manchester United – due to earlier elimination in the Champions League).

Part of the widening disparity reported in 2011 was down to
currency movements, as the exchange rate that Deloitte used for their last
publication was 1.11 Euros to the Pound. Since then, the Euro has weakened, but
even if we apply the current exchange rate of 1.25, the picture is basically
unchanged. Since 2009, the growth rate at Barcelona (€119 million) and Real
Madrid (€113 million) has been at least twice as fast as their nearest rival
(Manchester United €52 million). Of course, Bayern and Chelsea have yet to
publish their 2012 figures, but that is unlikely to significantly distort the
picture.

We should note that both clubs have provided moderate
revenue projections for the 2012/13 season: flat for Madrid, as lower revenue
from the summer tour (because of Euro 2012) is compensated by growth in other
areas; and a 5% decrease for Barcelona, partly due to no European Super Cup or
Club World Cup, with Faus admitting, “Each year it’s harder to find new revenue
streams.” However, it should also be acknowledged that they have often managed
to beat their revenue budget in previous years.

One other positive aspect of their revenue is how evenly
balanced it is between the three revenue streams. The split is almost
identical: broadcasting – Madrid 38%, Barcelona 40%; commercial – Madrid 36%,
Barcelona 35%; match day – Madrid 26%, Barcelona 25%. As Madrid’s annual report
puts it, this diversified structure provides economic stability, cushioning the
impact of potential revenue fluctuations arising from sporting factors or the
prevailing economic conditions.

Even though they have been remarkably successful in
producing a balanced revenue model, broadcasting revenue still provides them
with a key competitive advantage over their foreign counterparts, thanks to
their lucrative domestic deal. Unlike all the other major European leagues
which employ a form of collective selling, Spanish clubs uniquely market their
broadcast rights on an individual basis, so Madrid and Barcelona each received
€140 million in 2011/12, which was three times as much as the nearest
competitors, Valencia €48 million and Atletico Madrid €46 million, followed by
Sevilla €31 million and Betis €29 million.

In other words, Madrid and Barcelona on their own received
around 43% of the total TV money in La
Liga or 11 times as much as the €13 million given to the last club
on the list (Racing Santander). This unbalanced deal produces the most uneven
playing field in Europe and compares unfavourably to the 1.6 multiple in the
Premier League between first and last clubs. Such a revenue disadvantage is bad
enough for one season, but it makes a gigantic difference over time. As Sevilla
president del Nido complained, “The two giants have earned €1,500 million more
than the next club in the last ten years.”

Looked at another way, they received about twice as much
from their domestic deal as Premier League champions Manchester City, though
the gap should be halved from the 2013/14 season when the new English contract
kicks in. In fact, their TV revenue is more than the total revenue of all but
eight other clubs.

Both clubs have TV agreements in place until 2014/15, which
highlights one potential problem, as the rights holder Mediapro has experienced severe
difficulties leading to the company seeking bankruptcy protection over a
dispute with Sogecable.
Furthermore, other TV channels have spoken of not bidding for rights for
matches in future, due to the high price and depressed advertising market. That
probably explains why Faus admitted, “Media income has peaked and we don’t
expect increases in the next five years.”

"Every little thing he does is magic"

However, the strongest threat to this revenue stream is the
other clubs’ desire to move to a collective structure, as summarised by
Atlético Madrid’s president Miguel Ángel Gil Marín, “We want a league that is
solvent and competitive. To achieve that, it is fundamental that the gap in
budgets and revenues is narrowed and there is a fairer distribution of TV
rights.”

To date, this has been staunchly resisted by Madrid and
Barcelona, but Spain’s sports minister José Ignacio Wert believes that they are
now “receptive” to the idea of a more equitable distribution. Indeed, last year
Sandro Rosell said, “The television rights are negotiated individually now, but
in three, four, five years’ time, we will have to put them all in one pot and
make La Liga
as it is in Italy and the Premier League”, though his price is a reduction in
the number of clubs from 20 to 16.

That might sound like yet another slice of “pie in the sky”,
but there are reasons to believe that this might happen, not least that
collective agreements tend to be worth more than the sum of their parts. La Liga’s TV rights
revenue of €655 million is a long way behind the Premier League’s current €1.4
billion (rising to an estimated €2.2 billion in 2014). In fact, they have now
been overtaken by the Bundesliga
(€0.7 billion) and Serie
A, whose return to a collective deal helped grow TV rights to just
under €1 billion.

That is a huge prize to go after, especially overseas
rights, which is the reason why so many in Spanish football are now actively
pushing to make the “product” more attractive to viewers abroad, as articulated
by former Real Madrid legend Emilio Butragueño, “We want … a brand like the
Premier League. The best players in the world are here in Spain and we have to
profit from it.” Of course, that is easier said than done, especially in the
current harsh economic environment.

TV money has been boosted by participation in the Champions
League with both Madrid and Barcelona receiving around €40 million last season
from the central distribution. This again drives a wedge between them and other
Spanish clubs, as the less successful Valencia (€19 million plus €3 million for
parachuting into the Europa League) and Villarreal (€14 million) earned much
less. It was even worse in the Europa League, as Atlético Madrid and Athletic
Bilbao only earned around €10 million, even though they both reached the final.

Barcelona have consistently earned more money from Europe’s
flagship tournament than Madrid, thanks to their superior results, notably the
€51 million garnered when they won the trophy in 2010/11. That said, Madrid’s
improved performances under José Mourinho have resulted in revenue rising €12
million to €38-39 million in each of the last two seasons. The Champions League
bonanza shows little sign of slowing down, as the prize money for the 2012 to
2015 three-year cycle has increased by 22%.

Both clubs have adopted a strong commercial philosophy.
Marcel Planellas of the famous Easde business school compared Barcelona’s
strategy to a movie studio, “Just like Disney, you’ve got your stars, your
world tours, the box office, the television rights, the t-shirts and all the
other merchandising.” That description could equally apply to Real Madrid, who
have recently announced plans to build a $1 billion “football island” holiday
resort in the United Arab Emirates to strengthen their presence in the Middle
East and Asia.

In 2010/11, their commercial revenue (Madrid €172 million,
Barcelona €156 million) was only surpassed by Bayer Munich’s barely credible
€178 million, but was a fair way ahead of other clubs with Manchester United
being the nearest at €114 million. In Spain, it’s less of a gap to the next
clubs, more of an abyss with the difference being at least €125 million to
Atlético Madrid €29 million and Valencia €23 million. Note that Deloitte appear
to have re-classified membership fees to commercial income in their analysis.

Perhaps unsurprisingly, the shirt sponsorship and kit
supplier deals are the highest in football. Barcelona’s five year deal with
Qatar Foundation, running until 2015/16, is worth €30 million a year (plus €15m
for “commercial rights” in 2010/11) and is their first ever paid shirt
sponsorship. Rosell argued this was due to the arrival of wealthy owners at
other clubs, “If we did not have to fight against competition which has
capital, I would never sell anything on the shirt.” Madrid’s agreement with
Bwin, reportedly also worth €30 million, runs until 2012/13.

It’s not so rosy at other Spanish clubs with almost half of
the clubs in La Liga
starting last season without a shirt sponsor, including Valencia, Sevilla and
Villarreal. However, the bar is continually being raised at the leading clubs
with Manchester United recently announcing a spectacular deal with Chevrolet,
which will be worth an astonishing €56 million from 2014/15.

For kit suppliers, Madrid have just extended their deal with
Adidas to 2019/20 for €38 million, while Barcelona renewed their Nike deal in
2008 for €33 million to 2012/13 (with an option to extend to 2018). The closest to them are Manchester United
(Nike) and Liverpool (Warrior), who both earn around €32 million. An indication
of Madrid’s commercial strength came from the five-year secondary sponsor deal
that Emirates Airlines signed for €5 million a season, purely for some
“prominent” advertising space within the ground.

In terms of shirt sales, a survey by PR Marketing suggested
that Madrid and Manchester United lead the way with annual sales of 1.4
million, followed by Barcelona with 1.15 million.

Commercial income has also been helped by uplifts from
success like winning the Champions League and other activities, e.g. stadium
tours, ticket exchanges, though there are limits with both clubs unwilling to
play the Spanish Super Cup in China. Indeed, Faus cautioned, “advertising is
not immune to the current economic climate.”

Stop me if you’ve heard this one before, but Madrid and
Barcelona are also at the top of the league for match day income: in 2010/11
Madrid were first with €124 million and Barcelona third with €111 million. The
next highest in Spain were again miles behind: Atlético Madrid €30 million,
Valencia €27 million and Athletic Bilbao €25 million. This figure is impacted
by the number of matches played, e.g. progress in Europe, and other events,
such as Madrid hosting the Champions League final in 2010.

In recent years, the clubs have avoided raising ticket
prices too much. Indeed, Barcelona’s new board promised not to increase them
for two years, which they extended an additional year for the 2012/13 season.
However, there are hints that this may change with Faus talking about wanting
“to have a debate” on prices.

Both clubs also benefit from membership fees with Barcelona
reporting revenue of nearly €20 million from their 170,000 members. Madrid do
not explicitly break out their income, though they do list the fees paid by
their 93,000 members, implying revenue of €10 million.

Attendances are among the highest in Europe with Barcelona
overtaking Madrid three years ago, though their crowds fell last season to
76,000, around 1,000 more thantheir great rivals, even though Faus said that “ticket sales have been
spectacular.” One caveat here is that Spanish attendance figures are
notoriously inaccurate, as explained in this interesting article from Estadios de Fútbol en España.

Last month both clubs made announcements regarding possible
stadium development. Madrid unveiled four models to “turn the Bernabéu into a
world class arena”, which would cost €250 million, according to El Pais, and take
three years with the work starting next summer. Just two months after Rosell
said that Barcelona would put planned stadium renovations on hold until the
club’s debt had been further reduced, he announced a referendum whereby members
could decide whether to: leave the Nou Camp unchanged; redevelop it (last year
there were plans to add 10,00 seats and install new VIP boxes); or build a new
stadium. Faus indicated that redevelopment would cost €300 million, while a
full stadium move would be €600 million.

It is clear that both clubs have made efforts towards cost
containment. In particular, Barcelona cut their wage bill from €241 million to
€233 million in 2012. This gave some support to Rosell’s claim that “austerity
will be a pillar of our day-to-day management”, though sporting salaries still
rose by €17 million to €155 million, following the arrival of Fàbregas and
Alexis Sánchez. This was off-set by a €24 million reduction in bonus payments
to €44 million, as the club failed to retain La
Liga and the Champions League.

In fairness, the wages to turnover ratio has improved from
59% in 2010 to a very creditable 48% in 2012, though Faus conceded that “it’s
difficult to reduce the (wages) figure further and still maintain stability.”

As a technical aside, I have used the wages from Barcelona’s
detailed accounts here to be consistent with the University of Barcelona
analysis. The business review section of Barcelona’s annual report lists salary
costs as €268 million (sports €237 million, other €31 million), as this also
includes other costs, mainly image rights of €24 million.

In contrast to Barcelona, Madrid’s wage bill rose from €216
million to €234 million (almost identical to their rivals), presumably due to
bonus payments for winning the league, though they managed to maintain their
superb wages to turnover ratio at 46%. This may come under pressure from the
abolition of the so-called “Beckham Law”, which allowed foreigners to benefit
from a lower tax rate. As many players, such as the occasionally “sad” Ronaldo,
are paid net, the club potentially faces a sizeable increase in its costs from
2015, when the tax rate increases from 24% to 52%.

Again, these wage bills are considerably higher than other
Spanish clubs – at least €150 million higher in 2010/11 with Atlético Madrid
and Valencia the closest at just €64 million and €61 million respectively. Some
of the comparatives are almost laughable, e.g. Levante’s wage bill of €7
million is about 3% of Madrid’s.

As with revenue, it’s getting worse for the rest of Spain
with the wages gap ever widening. Between 2008 and 2011 Barcelona’s wage bill
rose €72 million, while Madrid’s increase by €49 million. In the same period,
the wage bills at Atlético Madrid, Valencia and Sevilla actually fell, while
Bilbao’s €14 million growth only took them to €49 million.

Their wages are also the highest in Europe, though
Manchester City and Chelsea were quite close with €209 million and €202 million
respectively. However, there are a couple of caveats. First, the exchange rate
can play a part, so City would have been higher than Madrid in 2010/11 at
today’s rates. Second, both Spanish clubs’ wage bills are inflated by other
sports. In Barcelona’s case, this amounted to €31 million in 2011/12, while
Madrid included around €23 million. Barca have targeted these for future
savings.

Despite this factor, Madrid’s wages to turnover ratio of 45%
was still better than both the financially prudent clubs (Manchester United
46%, Bayern Munich 49%, Arsenal 55%) and the more profligate ones (Manchester
City 114%, Inter 90%, Milan 88%, Chelsea 75%).

The other expense impacted by investment in the squad,
player amortisation, rose last year at both clubs: from €92 million to €98
million at Madrid and from €56 million to €61 million at Barcelona. For
non-accountants, amortisation is simply the annual cost of writing-down a
player’s purchase price, e.g. Karim Benzema was signed for €35 million on a
six-year contract with the transfer reflected in the accounts via amortisation,
which is booked evenly over the life of his contract, so around €6 million a
year.

The only other major football club with similarly high
player amortisation to Madrid is Manchester City with around €100 million. The
€37 million difference with Barcelona highlights their different approaches:
Madrid tend to buy in their stars, while Barcelona look to develop their
youngsters in-house. As Faus said, “There’s no need to spend €80 million, as we
have La Masia”,
which has produced Xavi, Iniesta and Lionel Messi (among many others).

This can be seen by the net transfer spend: in the last
seven years, Madrid’s €477 million was almost 80% higher than Barcelona’s €266
million. That said, there has been a sea change at Madrid with a distinct
slowing-down in the last three years, with net spend of “only” €128 million
compared to €349 million in the previous four years, when they launched the
second version of the Galácticos
project, buying Ronaldo, Kaká, Xabi Alonso and Benzema. It’s a similar story at
Barcelona where they have spent just €65 million (net) in the past three years,
less than a third of their €202 million outlay in the previous four years.

Faus has said that Barcelona’s average annual budget for new
signings will be €40 million. He added that any over-spend would be compensated
in future years, “Last year we surpassed our transfer budget with the signings
of Cesc Fàbregas and Alexis Sánchez. We cannot overspend our budget by 20 or 30
million euros each year, it would put our business plan at risk. It wouldn’t be
sustainable.”

Even with this more reasonable approach, the big two
continue to outspend the other Spanish clubs. In the last three years, most
have actually made money in the transfer market: Valencia €62 million, Athletic
Bilbao €27 million, Atlético Madrid €19 million and Sevilla €5 million. The
only leading club with a net spend is Malaga and that looks like a temporary
blip after their ownership problems.

Transfer spending was down 70% in La Liga this summer to
just €116 million with over half coming from Madrid and Barcelona (on Luka
Modric, Alex Song and Jordi Alba). Some clubs didn’t spend a single Euro on
player recruitment.

Given their financial weaknesses (and inability to compete),
the other Spanish clubs are effectively forced to sell their stars, thus
creating a vicious circle where the dominance of Madrid and Barcelona becomes
more firmly entrenched. As an example, in the past few years, Valencia have
lost David Villa, David Silva and Juan Mata, while Atlético Madrid have sold
Sergio Aguero, Diego Forlán and David de Gea. They either move abroad or
actually join Madrid or Barcelona.

Where the Spanish giants have to be careful is that they are
no longer the only game in town. In fact, over the last three years they have
been outspent by new money, particularly Chelsea (€272 million), Manchester
City (€244 million), Paris Saint-Germain (€242 million) and Zenit Saint
Petersburg (€151 million). Money talks, but oil money talks louder.

The most worrying issue for the Spanish giants, widely
reported in the media, has been their large debts, though this is open to
interpretation (as explained in this earlier blog). The press tend to use the
broadest possible definition of debt, namely total liabilities, which includes
trade creditors, accruals and even provisions. In 2012 this gives enormous
headline figures for Madrid and Barcelona of €590 million and €471 million
respectively. To place that into perspective, is the same measure were to be
applied to English clubs, Arsenal, universally applauded for their financial
prudence, would have “debt” of €585 million, about the same as Madrid and more
than Barcelona, while Manchester United are much higher at €890 million.

Under the more standard definition of net debt, Madrid’s
balance is only €30 million (bank loans of €143 million less cash €113
million), while Barcelona have €99 million (gross debt €136 million less cash
€37 million). Both of these are lower than Arsenal (€124 million) and
Manchester United (a hideous €458 million). However, Madrid also have
significant net transfer liabilities owed to other football clubs (included in
UEFA’s debt definition) of €55 million.

In 2010/11 Madrid (€590 million) and Barcelona (€578
million) had the highest debts in Spain, but this is cushioned by very good
debt coverage (revenue/debt) of around 80%. This ratio highlights the bigger
debt challenges faced by other clubs such as Atlético Madrid (debt €514
million, cover 19%) and Valencia (debt €382 million, cover 31%), though a
promising sign came last month from Miguel Cardenal, Spain’s secretary of
sport, who said that football club debts were declining for the first time in
decades.

Madrid have succeeded in slashing debt from €327 million in
2009 to €125 million in 2012, largely because of a significant reduction in
transfer liabilities. This is under their own definition, which is essentially
the same as UEFA’s (bank debt plus net transfer fees payable) plus selected
creditors (essentially stadium debt).

Similarly, Barcelona have cut debt by 22% in two years from
€430 million to €334 million, again using an in-house definition. This is a
fine achievement, considering the issues in 2009, when the club had to seek an
emergency €155 million to overcome short-term cash flow problems, including
paying the players. Faus has admitted that the debt is “still too high for us
to be able to dictate our future” and the club’s strategic plan aims to reduce
the balance to €190 million by 2015/16.

Madrid’s balance sheet is quite strong with €275 million of
net assets, which is much better than Barcelona’s net liabilities of €20
million (though this has improved €49 million in 2012). However, Barcelona have
“hidden” assets, as the players are only included in the accounts at book value
of €143 million, while Transfermarkt
estimates their real market value at a mighty €601 million.

Based on their strong financial performance in 2011/12,
UEFA’s Financial Fair Play (FFP) regulations, which force clubs to live within
their means if they wish to compete in Europe, should not prove overly
problematic for Madrid and Barcelona. The allowable losses are an aggregate €45
million for the first two years (then three years), but this is only €5 million
if losses are not covered by the owners, which might be more relevant here,
given that the clubs are owned by their members.

In any case, they can exclude certain expenses, including
depreciation on tangible fixed assets and expenditure on youth development and
community activities, which would be worth at least €20 million. On top of
that, they could argue that losses made by other sports should also be ignored,
though the FFP guidelines suggest that “other sports teams” might be included.

Perhaps the biggest threat to the financial ascendancy of
Madrid and Barcelona is the desperate situation of Spanish football in general.
Even though results on the pitch have never been better for the Spanish
national team and their clubs in Europe (five of the eight semi-finalists in
Europe last season came from La
Liga), most clubs are struggling off the pitch with a quarter of the
clubs in the top division in bankruptcy protection. As Professor Gay said,
“Many clubs are living dangerously.”

"So why so sad?"

The start of last season was delayed by a players’ strike
over unpaid wages and there were threats of similar this season, this time over
TV rights and schedules. This is exacerbated by the desperate state of the
Spanish economy, which is firmly in recession with unemployment running at a
record 23%.

With their new found focus on sustainability, Madrid and
Barcelona will be fine from a financial perspective, but it is conceivable that
fans may lose interest in La
Liga, due to the lack of competition. The financial disparity with
the rest of the league was always large, but it has become colossal, leading to
doubts about some clubs’ ability to survive. Professor Gay warned, “If things
go on like this, Spanish football will kill itself.”

At the moment, Madrid and Barcelona give the impression of
fiddling while the rest of the country burns, but they would do well to
remember the wise words uttered in Spider-Man (or, if you prefer, the works of
Voltaire), “with great power comes great responsibility.”

Praise for The Swiss Ramble

"Blogger of the Year 2013 - It’s testament to the effect that Kieron has had on the blogosphere that so many fans take his word as gospel. Putting to use his career in the world of finance, his insights into balance sheets and simple explanations of complex ideas appeal to the hardcore financial whizz and casual fan alike." - The Football Supporters' Federation